CVA / DVA — Credit Valuation Adjustment on OTC Derivatives Portfolio
Recording the Credit Valuation Adjustment (CVA — counterparty default risk reducing asset values) and Debt Valuation Adjustment (DVA — own credit risk reducing liability values) on the OTC derivatives book.
| Account Name | Type | Debit ($) | Credit ($) |
|---|---|---|---|
| CVA Charge (Reducing OTC Derivative Assets for Counterparty Credit Risk) | Asset (-) | - | 12,500,000.00 |
| CVA Expense / DVA Income (Net — Trading Revenue) | Revenue (-) / Income (+) | 12,500,000.00 | - |
💡 Accountant's Note
CVA is the market value of the expected loss from counterparty default on OTC derivative positions. It REDUCES the fair value of derivative assets — the firm values its receivables from counterparties at less than their risk-free value because those counterparties might default before final settlement. DVA is the mirror: the firm's OWN credit risk reduces the fair value of derivative LIABILITIES (if the firm itself defaults, it won't pay everything owed). DVA is deeply controversial — recognizing income when your own credit deteriorates (liability FV decreases). Both CVA and DVA flow through the income statement as 'net trading revenues.' In 2012, Morgan Stanley, Goldman Sachs, and other major dealers reported massive DVA gains as their credit spreads widened during the European debt crisis — profits from their own deteriorating creditworthiness that bewildered equity analysts.
Practitioner & Systems Framework
💻 ERP Architecture
CVA/DVA are calculated by a dedicated XVA (valuation adjustments) desk using: expected positive exposure (EPE) profiles for each counterparty, probability of default (from CDS spreads or internal ratings), loss given default, and netting set analysis (ISDA netting agreements reduce exposure by allowing offsetting positions). The XVA desk typically runs an independent CVA/DVA book — hedging CVA risk by buying CDS protection on counterparties. MVA (Margin Valuation Adjustment), FVA (Funding Valuation Adjustment), and KVA (Capital Valuation Adjustment) are additional 'xVA' terms that add further complexity.
⚠️ Audit Flags
CVA/DVA are Level 3 estimates — highly judgmental inputs (default probabilities, recovery rates, correlation assumptions). Auditors challenge the methodology and key assumptions. DVA income is particularly scrutinized — recognizing gains from own credit deterioration is counterintuitive and regulators have restricted it in certain contexts (Basel III capital rules limit the use of DVA in regulatory capital calculations).
📄 Required Documentation
CVA/DVA calculation model documentation, counterparty credit spreads (from CDS market or internal ratings), expected positive exposure profiles by netting set, probability of default and recovery rate inputs, netting set analysis (ISDA agreements), CVA/DVA P&L attribution, and xVA desk hedging activity.
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